Russian economy: stumbling due to war and sanctions, surviving with evasion schemes

Do sanctions work to punish Russia for its war in Ukraine? Not to the point where Ukrainians and all the democratic world would want to, and the ultimate point would be to force Putin’s regime to stop the war.

However, the sanctions are having an effect: practically all sectors of the Russian economy, with the exception of the military industry, are experiencing a lack of investment and modern technology imports. As a result, Russia is emptying the rest of the economy by spending so much cash and workforce on its army and the war. Some analysts believe it will not endure long. Let’s take a look at the sanctions’ impact.

Social and health expenditures suffer. According to Alexandra Prokopenko, a former Russian central bank official who wrote in Foreign Affairs, Russia is draining resources from the rest of the economy. “Russian industry has been transformed, with defense sectors now overshadowing civilian industries,” stated Alexandra Prokopenko.

For the first time since the fall of the Soviet Union, Moscow’s current military spending has eclipsed social investment, according to Prokopenko, a scholar at the Carnegie Russia Eurasia Center and a researcher at the Center of Eastern European and International Studies.

Russia has set aside roughly one-third of its budget for 2024 for defense spending. According to Russia’s government budget, social spending, which includes salaries, pensions, and benefits, will account for around one-fifth of the budget.

The military sector is also diverting civilian workers, resulting in a low unemployment rate of 2.9%. However, the military machine and Putin’s conflict consume vast amounts of public funds while producing no revenue.

So far, Russia’s sanctions-hit economy has managed to thrive thanks to sanctions evasion techniques, despite appearing to be resilient 23 months into its war with Ukraine. However, the sanctions loopholes are steadily closing. As a result, the Russian economy risks overheating, and the Kremlin’s ability to sustain its conflict in Ukraine may wane.

The war in Ukraine is seriously affecting Russia’s economy, raising prices in the country, and forcing Moscow to allocate a third of its budget on defense. According to the Financial Times, Moscow spent more than $100 billion on military in 2023, accounting for about a third of total expenditure.

Western countries imposed extensive sanctions on Russia in response to its invasion of Ukraine in February 2022. The European Union adopted in December the 12th sanctions package targeting Russia’s diamond trade and sanctions evasion schemes.

Top-10 sanctions imposed on Russia

  • G7 price cap on Russian crude oil and refined products. The EU banned imports of most refined products, seaborne crude oil, and coal, and the U.S. completely banned Russian fossil fuels.
  • G7, US, and EU bans on Russian gold imports.
  • The US and EU ban trade in Russian diamonds.
  • SWIFT ban for 10 Russian banks, including Sberbank.
  • Asset freeze of the Central Bank.
  • Export ban on high-tech goods, including products that could be used for military purposes, chips, and aircraft components.
  • EU ban on providing several services to Russia, including crypto accounts, IT consultancy, and credit rating.
  • EU and US bans on investment in Russia’s energy sector; EU ban on investment in mining and quarrying.
  • Asset freezes and travel bans for around 9,000 Russian individuals and 1,800 companies.
  • Germany suspended the certification of Nord Stream 2.

As a result of the Kremlin’s war in Ukraine, the Russian economy contracted by 8.5 percent in 2022. Western sanctions on Russia have disrupted trade flows of Russia’s primary export and import goods, such as fossil fuels, technology, and equipment.

The sanctions have also led to price increases, with 2022 inflation reported to top 21.3 percent. In response to the war, hundreds of international corporations in Russia ceased operations, leaving their employees facing the prospect of layoffs.

With the support of economic militarization, the Russian government was able to reduce inflation and unemployment in 2023. However, according to Statista, real GDP will fall by 2% in 2021–2023, while inflation will reach 6%.

The US Treasury Department published an analysis by Chief Sanctions Economist Rachel Lingas of the constraints on Russia’s access to the financing and material resources required to wage war.

Russia’s productivity has dropped as a consequence of the war, the impact of sanctions, and economic pressure from the United States and its partners. Russia is under increasing financial strain as a result of rising expenditures and the impact of sanctions on its revenues.

The Russian economy has seen currency volatility, with the ruble falling, then rebounding, then falling again, and now down nearly 20% versus the dollar from early February 2022 to December 2023.

The Russian government has raised the defense spending objective for 2023 to more than $100 billion (a third of total government expenditures), while delaying public salary hikes scheduled for 2024. As a result, the population’s standard of living has declined. In addition, the army drafted hundreds of thousands of soldiers, resulting in the deaths of thousands.

Out of fear of being called up for Putin’s war, thousands of highly skilled specialists fled the nation. The invasion of Ukraine has also caused around 500,000 Russians to emigrate, resulting in a scarcity of highly skilled workers and blue-collar jobs.

Moscow’s energy revenues have fallen substantially while spending has increased—by over 40% from January to October 2023 compared to 2022. This drop reflects a variety of variables, including a drop in global oil prices through 2022 and much of 2023, as targeted sanctions regimes prevented the huge Russian supply disruption that markets anticipated following the invasion.

Given that oil and gas tax revenue are important sources of funding for Russia, this fall in revenue puts additional strain on the country’s fiscal balance. The rise in global oil prices since summer 2023 permitted some recovery in Russia’s sales, but increased enforcement of the price cap along with associated sanctions regimes keep limiting revenues.

Despite EU limitations, only around one-third of pre-war Russian exports are fully sanctioned; the balance of trade is either unaffected or subject to many exemptions. While exports have declined by 32%, imports have surged by 17% as a result of creative ways to circumvent trade prohibitions, according to the EconPol report.

The Russian government responded to the sanctions by boosting commerce with non-sanctioning countries. Western sanctions on Russia’s oil trade have not had the expected impact, as Moscow has diverted its energy supplies to China and India.

Russia’s reliance on its “shadow fleet” persists, implying that the cap’s leverage is rapidly fading. Recent measures toward increased enforcement are positive, but more will be required to have an influence on Russian macroeconomic stability.

Foreign investments have dried up. They used to be $5–15 billion monthly in 2018–2021, but after the invasion of Ukraine, it became a withdrawal of foreign capital from Russia, with over 1000 Western businesses leaving and no new investments. Despite the withdrawal of foreign capital from Russia and over 1,000 Western businesses leaving with no new investments, several worldwide corporations chose to remain despite criticism.

The Nord Stream 2 natural gas pipeline, on which Russia and its investors spent over $11 billion, has been abandoned.

In sharp contrast to Putin’s upbeat narrative of 3.5% growth (based solely on military spending), experts present a gloomy picture of Russia’s economy. This growth conceals a fundamental shift in resource allocation. Russia diverted significant economic resources to military manufacturing. The sanctions and Putin’s war forced Russia to make trade-offs, leading to the forsaking of other sectors of its economy, such as health and education, in order to produce weapons.

Inflation is also becoming an issue. Russia’s inflation rate has already topped 7%, forcing the Bank of Russia to keep interest rates at 16%. Despite the high interest rates, firms and families’ continued borrowing signals the expectation of high inflation. The high interest rates are an image problem, undercutting Putin’s notion of a healthy Russian economy.

The Kremlin seeks to retain the appearance of normalcy while also generating affluence for its citizens. However, the Russian economy’s reality remains bleak. With better sanctions enforcement and a complete ban on dual-use technology, even via third countries, the military industry will halt and begin to stumble.

The sanctions have not caused Putin to withdraw his troops from Ukraine. However, sanctions on Russia were only some of the finest tools available, together with military assistance to Ukraine, to respond to Russia’s violations of international law without resorting to direct military intervention. As of January 2024, the sanctions had had a considerable but non-decisive impact on the Russian economy. Closing penalty evasion schemes would increase their effectiveness by several orders of magnitude.

While Western sanctions have not prevented Russian war aggression, they have achieved several goals in the last two years. The sanctions have a deferred effect. Their pressure grows over time, exacerbated by dropping oil prices and oil cap price enforcement. To have a complete impact, Western nations must eliminate all evasion routes through China, Kazakhstan, Uzbekistan, Armenia, the UAE, and other countries.

Putin’s war is trembling Russia’s economic stability, and the consequences of a shift to military manufacturing are already obvious. As a result, the coalition of sanctioning powers should refine and strengthen these efforts as a critical source of assistance for Ukraine. The success of sanctions enforcement determines how rapidly the Russian military machine slows down.

To maintain military spending, Putin will be compelled to make additional trade-offs and sacrifice more economic sectors in the midst of his next election campaign. The Russian dictator has demonstrated that he will not give up his geopolitical aspirations and goal of conquering Ukraine. However, these objectives are incompatible with economic objectives, and a prolonged war will become Putin’s regime’s last-ditch survival effort.

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